CD Knockout – Knockout Barriers Explained

When using investment CDs, you may come across the term knockout (or “knock out”).

What is a market knockout on a CD?

The knockout level is where you don’t want the market to go. If the market reaches your knockout level, you are “knocked out” of market participation. Instead of enjoying future gains, you’ll only receive the “guaranteed return” from your investment CD.

In most cases, the guaranteed return is just that you get all of your money back. If the market went straight down and stayed there, this is not a bad thing. However, market-linked CDs may have long lives, and the market may end up much higher than where it was when you got knocked out.

Even worse, you can get knocked out if the market does too well. In that case, you would have been better off putting your money in the market instead of using a market-linked CD.

EXAMPLE PLEASE

So, how do these knockouts work?

You are market-linked CD is described in various disclosure documents. In those documents, look for the knockout terms. It may be called a “knockout level” or “upper/lower barrier”.

The knockout barrier is usually described as a percentage change in me the underlying investment. For example, your market-linked CD may have an upper barrier of 150%, and the lower barrier of 85%. Let’s assume the underlying investment (perhaps it’s a stock market index) is at 1000 when your CD is issued. If the investment moves above 1500 or below 850, you are knocked out.

If that happens, you’ll have to wait until your CD matures to get the “minimum guaranteed” return. In most cases, you’ll just get 100% of your money back. If you’re lucky, they’ll pay you a minuscule interest rate on your initial deposit.

As you can see, your goal is to have the market move up slowly. In an ideal world, it would go up 149% – giving you about as much return as you can get without hitting the knockout barrier.

FUNKY KNOCKOUTS

Knockouts can be simple or complex. You may have one knockout level, or you may have many. Again, you have to read the fine print (ever heard that one before?). The knockout could be 150% from the starting level, where there could be different knockout levels calculated each year.

Likewise, knockouts can be biased towards the upside or the downside. An upper barrier of 200% and a lower barrier of 95% makes sense if you think the market will go up. However, a different market-linked CD may have an upper barrier of 150% and a lower barrier to 50% (a more neutral setup).

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